"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, May 14, 2014

Ten Year Treasury Yield Plunges

I am still trying to make sense out of what is happening in the interest rate markets this morning, given that strong PPI number. The yield on this key Treasury ( and one of my favorite indicators ) has plunged to the lowest level since October of last year!

From a technical analysis standpoint alone ( I am not considering anything fundamental ) the chart has experienced a downside breakout. There is one last level of chart support back at those October lows near 2.46 - 2.47%.

Did the Fed just start a new QE program and I missed it? Some of the Treasury buying in recent weeks has been attributable to safe haven flows related to events in Ukraine but that in and of itself is not sufficient to have produced the steady influx of buying in the Treasury market.

Why this is so noteworthy in my mind is that the Fed has provided forward guidance suggesting that while their tapering plans will proceed, no interest rate hikes are being considered until 2015-2016. Most of the big players split the difference and projected no hikes until mid-2015.

However, if the PPI, which is notoriously more volatile than the CPI, shows a trend towards higher wholesale prices, then that would bring into question any rate hike delay of that length of time. We really do need to see that CPI number tomorrow to get a sense of what is taking place.

As you can see, there are a lot of uncertainties right now. I can tell you one thing, mortgage company risk management departments must be spinning this morning. Imagine trying to initiate a hedging program in this environment. One day we are getting surging payrolls numbers and chatter of higher rates. The next day rates are plunging lower. No wonder we are getting the types of wild swings in prices in so many markets. Commercial hedging interests are also getting whipsawed and ripped to shreds let along hedge funds who are experiencing some sizeable losses.

Traders - be careful - watch the size of those positions you put on. Keep them manageable or you are going to end up with some big losses if you are not glued to your computer screen.

On Tap for Tomorrow

In light of that strong PPI number this morning, tomorrow's release of the CPI will perhaps take on some added significance. The market is expecting a 0.3% rise compared to the 0.2% rise last month. When food and energy are excluded, the consensus is a 0.2% rise.

Interestingly, the market is expecting industrial production to have actually fallen in April. The number in the market is a 0.1% decline compared to a previous month 0.7% increase.

Jobless claims are expected at 320K compared to the previous 319K.

The huge rally in the bond market continues at this hour. Yield on the Ten Year has fallen to 2.548%. That is astonishing given the PPI reading.

It is also helping to explain the  continued strength in gold which thus far has been holding above $1300.

Copper, after moving lower on China news yesterday is now moving higher on China news today... Think about that for a moment and then realize why trading commodities is such a difficult game for so many people starting out.

Crude oil is up after the EIA released data showing an unexpected BUILD in supplies. However gasoline stockpiles fell 772,000 barrels when the market was looking for a 100,000 increase. Distillate stocks fell 1.1 million barrels against an expected 600,000 increase.

The products number kicked crude back up after it had an initial knee-jerk response lower. Crude is now trading near $102.50, and is back above the key $100 barrel mark. Coming on a day in which the PPI was sharply higher, higher energy prices are fanning the inflation fames.

I shudder to think where we would be here in the US were it not for this massive shale oil production.

PPI numbers send Precious Metals Higher

The Producer Price Index, PPI, which measures prices at the wholesale level, came in sharply higher than expectations this morning, and sent both gold, and especially silver, strongly higher.

The April reading rose 0.6% for the month, well above the 0.2% increase that the market had baked into the cake. That was the sharpest rise since September 2012. When the usually volatile food and energy component was stripped out leaving the core measurement, the number rose 0.5%. The market expectation for the core reading was a 0.2% increase. The number caught the market by surprise and forced a good-sized round of short covering in the PM complex.

The Federal Reserve is no doubt welcoming this PPI number ( the governors are probably doing cartwheels in the hallway)  as they have been scared to death of deflation. Their goal is to produce an annual inflation reading of 2%.

As mentioned yesterday, silver MUST have inflation to rally and rally it did, although I am noticing that once again it has been stymied at the $20 level.

One would have thought that the bond market would have fallen on the news, meaning interest rates on the long end would have risen but oddly enough, they fell lower. I am still trying to make sense out of that. Same goes for the US Dollar which could have been expected to move higher alongside higher US interest rates. That both moved lower has me scratching my head right now and wondering what is the thinking behind this.

If the market was convinced that the uptick in price pressures is the development of a new trend, then that would lend credence to the view that the Fed would raise interest rates sooner rather than later. That would support the US Dollar, especially against the Euro where the discussion over there centers around lower rates. The long bond however is now up over a full point as I type these comments early in the session. Obviously the bond market is not the least bit concerned about inflation pressures. So what in the world is going on? Gold and silver are thinking "inflation" and bonds are thinking ????? - Deflation! Why else would they be moving higher today and sending rates lower on the long end?

The bond vigilantes must be punch drunk.

This is going to be very interesting to monitor to see whether or not it is the beginning of a trend or another one of those "one off's". Also, we will want to see if the feds show any sort of change in the CPI, which measures prices at the retail level to see if producers are passing the price rises along to end users or are absorbing those.

One thing that has me a bit skeptical that we are witnessing a huge shift towards an inflationary bias right now is the forward structure in the grains and beans. Grain prices, if we get a good growing season ( and this is of course always a question), are showing ample supplies for later this year which will mean lower costs. Also pork production, along with beef production, is expected to increase late this year and into next spring, although it will not be burdensome. China's slowing growth is also a negative factor for commodity prices in general so all of this needs to be considered. That being said, I am looking at this data with an open mind and watching closely. Again, this big bond rally today has me really skeptical as the bonds are usually right. We'll see.

Stocks certainly did not like the news one bit. Keep in mind that one of the big drivers behind the consistent rise in equities has been the lack of inflation. An ultra low interest rate environment has thus far driven money flows into stocks. If, and this is a big, big "IF", we do see a shift towards an inflationary bias in these PPI's and CPI's, we might finally see a bit more selling pick up in equities.

I will get some more up later in the session. Let's see how things close today.